TINA Turning?

All I want is a little reaction
Just enough to tip the scales
--Tina Turner

During the era of interest rate suppression, people turned to stocks, particularly dividend payers, because it seemed there was no alterative (TINA). With yields presently moving higher, the TINA attitude should dissipate as investors switch out of stock in favor of the relative safety of high yielding bonds.

Today the 2 yr Treasury yields touched 4%. This more than 2x the S&P 500 dividend yield.

The higher this spread goes, the more pressure we should see on stocks as investors flock to 'risk-free' cash yields.

Positioning for Retirement

Doing the garden
Digging the weeds
Who could ask for more?
--The Beatles

With retirement coming up fast I've been doing a few things w.r.t. personal finance. I've been saving more and spending less in order to build cash. Have also been selling some stuff on ebay and elsewhere to collect extra 'juice.' Also helps thin things out at the house--much needed.

Preparations are being made to rollover my 401(k) from work. I'm looking forward to allocating this capital among far more choices than those available thru the current fund administrator.

In both my brokerage and IRA accounts, I've been buying dividend paying stocks. Dividends are real cash that can provide a significant, and perhaps under-appreciated, income replacement in retirement.

Inflation is particularly bad for retirees as it erodes purchasing power of savings. To hedge against the prospects of Big Inflation, I've been building stock positions in the oil complex (e.g., ENB, XOM) and miners (e.g., AEM, AGI, PAAS). 

The miners appear particularly attractive. The financial strength of many in this group has perhaps never been better. Solid balance sheets and cash flows. Many are paying significant, and increasing, dividends (which helps me kill two birds with one stone). The sector has been pounded down to attractive valuation levels--particularly given the growing inflationary environment.

I've been swapping funds out of precious metal ETFs such as PHYS and into the miners to more fully express my perception of this situation--albeit at a slightly higher risk profile. 

positions in AEM, AGI, ENB, PAAS, XOM

Inflation and Stocks

Hundred dollar car note
Two hundred rent
I get a check on Friday
But it's already spent
--Huey Lewis & the News

Some believe that if Big Inflation cometh, stocks will get creamed. Surging prices will drive folks to spend less. Simple ECON 101.

Lower demand for goods and services should be bad for stocks.

A counterargument is that Big Inflation occurs when people get nervous about the value of their dollars sitting idle, so they put them to work today assuming that they can buy more today (i.e., goods, services, AND stocks) than tomorrow. The psychology feeds on itself, creating, in its ugliest form a reinforcing cycle of higher prices and money printing that feeds it.

Although producers are hurt on the input side with higher costs, they can offset them at least partially by raising prices, thereby preserving profit margins to some degree. To the extent that producers own tangible assets, these are also likely to appreciate in value as inflationary pressures rise--giving a boost to book value at least in nominal terms.

In this scenario, stocks are likely to rise. Perhaps not to a degree that completely compensates for purchasing power decline, but at least to serve as a partial hedge that preserves wealth (note Kyle Bass estimates perhaps 85% coverage).

Historical analysis supports this thesis. Weimar Germany, Venezuela, Zimbabwe. Equities tended to rocket in the local currency--even if they didn't keep pace with exchange against more stable currencies (and gold).

One thing seems increasingly clear. In Big Inflation environments, stocks are likely to be a better place to be than cash.

It also seems that, in the current market environment where the CPI is starting to print some big numbers, stocks seem unfazed--like they want to go higher.

position in gold

Unfadeable

Day after day it reappears
Night after night my heartbeat shows the fear
Ghosts appear and fade away
Come back another day
--Men at Work

The S&P 500 (SPX) closed the holiday-shortened week north of 4000--an all time high. Strength of bids underneath many individuals names is as firm as I can remember.

The contrarian in me says fade this tape. But then I'm reminded of the ocean of newly minted cash that is raising prices higher. 

Inflation Math

So hold on
Here we go
Hold on
To nothing we know
--The Motels

M1 is considered the narrowest, most liquid form of money. Physical coin and paper money, demand deposits, traveler's checks, other checkable deposits (OCDs), and other liquid deposits including money market deposit accounts. This is the form of money closest to making purchases and paying bills.

As you can see from the graph, M1 money stock has, um, grown significantly in the past year. The surge is primarily a function of the Fed's debt monetization operations to counter negative economic impacts of CV19.

Do the math: supply chain shortages + pent up demand + a mountain of new minted cash = ?

Wave of Cash

We'll all be planning that route
We're gonna take real soon
We're waxing down our surfboards
We can't wait for June
--Beach Boys

Comparison of Fed's current round of monetization (a.k.a. 'quantitative easing' or 'QE') compared to previous versions.

Within the span of a few weeks, the Fed has added more balance sheet assets than any previous QE program did in its entirety. And those programs lasted 1-2 years each.

The upshot is that 2 trillion dollars created out of thin air by the Fed have recently been released into the financial system. We've seen what this manufactured money has done to asset prices such as stocks.

What do you suppose happens when this wave of freshly minted cash splashes its way onto the shores of goods and services markets?

Illiquid Scenario

"1929. It'll get worse now 'cause it'll go faster. Money markets will dry up round the world by the end of the week."
--Julie Steinhardt (Wall Street: Money Never Sleeps)

When people are not working, they lack income to pay their bills. If they don't have savings, then they have nothing to fall back on. If they are in debt, then things are worse because a portion of their bills are loan repayments. If they miss those payments, then they are in default.

This is the situation developing in corporate America right now. Because many businesses are no longer working--or working at fractions of capacity--due to coronavirus concerns, their incomes are drying up. Cash flows may be insufficient to meet current obligations. Moreover, nearly all firms are leveraged, meaning that the less they produce and sell in this environment, the closer they get to missing debt payments due to lack of cash.

Not surprisingly, short term money markets are showing signs of stress as businesses scramble to tap credit lines to make ends meet.

Investors are beginning to discount the illiquid scenario.

Monetization and Prices

I never meant to be so bad to you
One thing I said that I would never do
--Asia

Suppose the Fed, thru its debt monetization activities, creates $1 million out of thin air to buy some bonds from one of its primary dealers, JP Morgan (JPM). The Fed lifts $1 million worth of Treasuries, agencies, et al from JPM's inventory in exchange for the newly minted cash.

Being a financial institution, JPM is likely to put the money to work thru lending or investing activities. Let's say that JPM uses the $1 million for proprietary trading in stocks. It might even lever up its trading capital to get extra bang for the buck.

Regardless of how it is used, the bulk of the $1 million remains in the financial system somewhere. Unlike credit money that exists only as long as the borrower has appetite for leverage, money created for monetization purposes persists unless/until the Fed reverses its initial transaction and sells its bonds on the market--at which time the Fed reclaims and retires the $1 million that it had previously printed.

As expected, the $1 million that JPM deploys causes prices to rise while it is in the market. But because JPM and other financial institutions are the early beneficiaries of the newly minted cash, it is primarily the prices of financial assets that rise. Stocks, bonds, real estate...whatever the banks buy with the $1 million go up in price. Importantly, as long as financial assets go higher in price, most of the $1 million dollars of newly created money remains locked in the financial system.

This is why we do not see broad consumer price increases from central bank monetization activities--at least initially. Financial assets prices can shoot toward the moon (as we have seen) while the prices of break and milk remain relatively stable.

If for some reason prices of financial assets begin to fall, then the balance might shift. Lower prices will drive investors to sell and pull money out of the financial system. When this occurs, the $1 million is released from the financial system begins to make its way into the every day economy.

This is when we'll see the price of goods and services rise in earnest.

The formal propositions are as follows:

Proposition 1a: When money is created for central bank monetization activities, the printed money will be used by financial institutions to buy financial assets, thus driving asset prices higher.

Proposition 1b: When prices of financial assets subsequently decline, the printed money rotate out of the financial system into the everyday economy, where it will be used by consumers to buy goods and services, thus driving consumer prices higher

no position

New Year's AA

Sometimes you picture me
I'm walking too far ahead
You're calling to me
I can't hear what you've said
Then you say, "go slow"
And I fall behind
The second hand unwinds
--Cyndi Lauper

Every now and then I like to estimate my asset allocation (AA) across all financial accounts. Helps keep me aware of where I stand.  Here's my current AA as we usher in the new year:

Equities   40.3%
Fixed income   1.0%
Cash   48.0%
Alternative assets   10.7%

Note that this breakdown is for securitized (i.e., paper) assets only. It does not factor in physical assets such as my house.

Fixed income portion would be higher if my work 401(k) would make certificates of deposit (CDs) available. Instead, I have to settle for money market funds that currently yield close to CD rates (although they do not provide FDIC protection). If CD's were available in the 401(k) account then I would be targeting an asset allocation of ~ 40 equities/30 fixed income/20 cash /10 alt assets.

Top stock holdings include D, INTC, JNJ, MRK, PAAS, WFC, XOM. Alternative assets consist largely of closed end gold and silver funds CEF and PHYS.

Asset allocation should evolve this year as funds from pension fund buyout are allocated primarily toward dividend paying stocks and precious metal proxies.

Policy Uncertainty and Inflation Expectations

"Remember, sometimes when you're blind, and times seem darkest, you can often see more clearly."
--David Sloan (Kickboxer 2)

Article suggests a negative relationship between policy uncertainty and inflation expectations. The greater the policy uncertainty, the lower the expectations of inflation.

This is not necessarily intuitive. I suppose the argument goes like this. When people have trouble predicting what will happen in the institutional/regulatory environment, they will hoard cash and pull back on purchases (kind of like the 'wait and see' approach to investment advanced by researchers). Expectations of price increases therefore decline.

But we've seen the opposite as well, haven't we? In unstable policy environments, people can get nervous about holding onto cash because it might degrade in the future. Dumping cash on the market causes expectations of prices to explode higher. A reinforcing cycle commences where Big Inflation motivates even bigger inflation expectations.

The relationship between policy uncertainty and inflation expectations is moderated, it seems. What are those moderating variables?

Raising Cash

"He's right, you know, I had to sell. The key to the game is your capital reserves. If you don't have enough, you can't piss in the tall weeds with the big dogs."
--Gordon Gekko (Wall Street)

Although investing involves acquiring financial assets and holding them for long-term payoff, every now and then investment positions may need to be liquidated to raise cash for urgent near-term matters. For example, portions of an investment portfolio may need to be sold to free funds for extinguishing unwanted debt.

Suppose that you hold a stock portfolio with 40-50 positions, many of them inherited, in a taxable brokerage account and you want to sell some holdings to raise cash. How to determine what to sell? A few thoughts:

1) Know what you own--and what you don't want to own. Review the names in your portfolio. What companies do I own? What industries are they in? What are their dividend yields? Be on the lookout for positions that you're not happy with. Some companies may be making strategic mistakes that are weakening their competitive position. Kraft Heinz Co (KHC) was a holding of mine that I thought fit this category. Some companies may be operating in sectors that don't excite you. Lack of enthusiasm for the tobacco and military sectors caused me to look hard at positions in Altria Group (MO) and Lockheed Martin Corp (LMT) when I wanted to raise cash. If you identify positions that you don't feel good about, then these are prime candidates for sale.

2) Are any holdings grossly overvalued? Reflect on the valuations of your holdings with a focus on positions that appear over-priced. Be aware, though, that valuation is a tricky exercise and that general conditions of overvaluation are usually NOT good reasons to liquidate. Stock prices sometimes get ahead of themselves a bit because the story is good and improving. In most cases, it pays (literally) just to hold on and enjoy the ride. Trading in and out of names based on point estimates of valuation is often a losing game. However, in some cases a security's price has been bid so far to the moon that it might make sense to sell. As solid as the company is, the current valuation of Microsoft (MSFT) prompted me to sell a couple months ago at what I perceived to be an extremely rich valuation. I may be wrong, of course (the stock price is up 10-15% since I sold it). But exchanging my MSFT shares for cash was a worthy trade for me at this juncture. Plus, there is nothing stopping me from buying the stock back should things change in the future.

3) Look for opportunities to pair capital gains with capital losses. In a taxable brokerage account, when you sell stocks that have appreciated in price, you will be obligated to pay taxes on the 'capital gains.' However, tax liability can be reduced if you offset capital gains with losses from positions sold for less than their purchase price. For example, I sold some of my losing position in Gap Inc (GPS) earlier this year to offset gains realized by selling winning positions like MSFT discussed above. Every now and then, it makes sense to prune losing positions to obtain a 'tax asset.'

4) Strive for a manageable number of positions. The higher the number of stocks in a portfolio, the greater the degree of diversification, BUT the harder it is to keep track of all positions. Personally, I've found that ~30 positions is my limit. Beyond that, I struggle to stay on top the news flow vital to ongoing fund management. When raising cash, there may be opportunity to reduce portfolio positions to a more manageable number.

Selling can be a hard thing to do. Assets that you've owned--particularly those that have been productive--are often difficult to let go. When done in taxable accounts, the tax bite can also sting. When thoughtfully done, however, raising cash from an investment portfolio can be a healthy exercise. Not only does it enable the funding of immediate needs, but selling also serves to prune and streamline a portfolio so that the remaining assets work better for you in the future.

position in GPS

Selling Strength

"He's right, you know, I had to sell. The key to the game is your capital reserves. If you don't have enough, you can't piss in the tall weeds with the big dogs."
--Gordon Gekko (Wall Street)

Stating the obvious, the best time to sell is when prices are high. But this is easier said than done. Account values are swelling. Plus, prices could go higher yet.

That said, I'm selling strength here as markets challenge all time highs after this morning's strong job report.

Need to have some extra liquidity for projects over the next year. To obtain it, I'm happy to 'feed the ducks' during rallies like this.

Situational Awareness of Markets

I follow you around but you can't see
You're too wrapped up in yourself to notice
--Madonna

An important factor in making sound investment decisions is situational awareness about markets. Generally speaking, situational awareness is a state of knowledge and sensitivity about the environment that you're operating in. People with high situational awareness perceive critical forces at work around them, understand their meaning, and project what can happen to a system in the future.

Stated differently, the more you know about the surroundings that you're operating in, then the better you'll be able to operate.

Situational awareness starts with understanding important concepts and their relationships in a decision-making domain. In the investment domain, we've considered many core market concepts over the past few months.

Once you've grasped concepts, you have to put them to work. By this I mean observing what goes on routinely in the socio-economic reality of markets--the happenings that bring concepts to life. The more you immerse yourself in the flow of events, the more situational awareness you'll gain.

Here are some ideas for developing greater situational awareness of markets:

Start with a watchlist. Apps abound that enable you to create lists of stocks, bonds, commodities, indexes, et al. whose prices you want to track. Because prices are a central expression of market behavior, understanding price levels and trends is an effective way to elevate situational awareness of markets. Watchlist apps often include charting capabilities as well as relevant headlines. My favorite watchlist app came with my iPhone. I usually roll through my watchlist at least once/day.

Review the news flow. In the dark ages prior to the internet, staying apprised of business and market headlines took some doing. I would spend hours scouring daily newspapers like the Wall Street Journal and Investor's Business Daily plus weekly magazines like Business Week and Fortune to stay apprised of events. Cable TV stations that catered to investors, such as CNBC, Fox Business, and Bloomberg, subsequently added to the process of assimilating information. Today, these media outlets, alongside many others, operate websites that stream news flow 24/7 to the convenience of investors. My recommendation is to locate a source or two that you like, and then visit regularly. Over time, you'll be stunned at how much situational awareness you'll acquire by 'osmosis.'

Keep tabs of your personal financial situation. What is your current asset allocation? What stock positions are you holding? How much dividend income are you collecting on an annual basis? How much cash have you set aside to fund life's expenses? Good situational awareness of markets requires that you are aware of your own financial situation! Establish a routine where you review your financial situation regularly. You might start with account web pages or statements generated by your broker or bank. To make the process active rather than passive, consider setting up spreadsheets that require you to plug in up-to-date data regarding your accounts. You might also consider a spreadsheet that aggregates information across accounts so that you can estimate overall asset allocation.

As your situational awareness of markets improves, so will the quality of your investment decisions.

Beginner's Portfolio Template

"First learn stand. Then learn fly. Nature's rule, Daniel-san. Not mine."
--Miyagi (The Karate Kid)

How to tie what we've discussed about investing so far into actionable outcomes? Here's a template of sorts for what a beginner's investment portfolio might look like:

Equities* 
stock 1
stock 2
stock 3
stock 4

Fixed Income 
CD

Cash and Money Market
money market fund
residual cash

*Shoot for four equity positions of the dividend paying, anchor stock variety

How much to allocate to each asset class? Because young investors have time on their side, they can afford asset allocations tilted toward more equity exposure. Aggressive designs might even ignore fixed income in favor of more stocks (particularly if those stocks generate income).

On the other hand, if your risk tolerance is lower or if you are less confident in the outlook for equities, then a more balanced or cash rich allocation with fewer equity positions makes more sense.

Keep this template in mind while assembling your own portfolio.

Balance Sheets

Shine sweet freedom
Shine your light on me
You are the magic
You're right where I want to be
--Michael McDonald

In the last two missives we examined income statements and cash flow statements. The last of the financial statement trilogy is the balance sheet. We touched on the balance sheet a few posts ago when discussing net worth. A balance sheet reports what is owned (assets) and what is owed (liabilities). The difference between the two is called net worth, or in the case of investors, 'shareholder equity.'

The key information I like to glean from a balance sheet is how much cash a company has versus how much debt it has. Cash is freedom and flexibility while debt, as we have noted, reduces freedom and limits future options. Cash, short term investments, and other cash 'equivalents' are usually the first thing reported under the Asset section of the balance sheet. Once again returning to our Intel (INTC) example, the company's most recent annual balance sheet reports $3.0 billion in cash and cash equivalents and another $2.8 billion in short term investments (all of these are liquid, cash-like assets). Intel's total cash, then, is $3.0 billion + $2.8 = $5.8 billion.

We can also see that the company's total cash has been declining over the past four years (it had been $18 billion in 2015). That's a negative. We'd rather see it going up over time.

Now let's look at long term debt, usually reported near the end of the Liabilities section. For its most recent fiscal year, Intel reports $25.1 billion in long term debt. Long term debt has also been increasing over the past four years. That's undesirable; we'd rather see it going the other way.

We can compare cash to debt in a couple of ways. We can find 'net cash' by subtracting long term debt from total cash. For Intel, net cash = $5.8 billion - $25.1 billion or -$19.3 billion. We could also calculate the ratio of cash to long term debt: $5.8 billion/$25.1 billion = 0.23.

The strongest balance sheets are those where there is more cash than long term debt (positive net cash; cash:debt > 1.0). That way, a company can quickly use cash to extinguish debt and gain more flexibility.

Once upon a time, many companies operated with strong cash positions. Unfortunately, in the debt-laden world that we live in, that kind of balance sheet strength is largely a thing of the past. Most corporate balance sheets have weakened considerably. Not too long ago, Intel had gobs of cash and zero debt--a bastion of balance sheet strength. Personally, I've had to become more comfortable situations like Intel's and resolve to invest in companies with balance sheets that are 'less bad' than others.

That completes our synopsis of the financial statement trilogy. With a little practice you can navigate these statements like a pro for info that will make you a more knowledgeable investor.

position in INTC

Cash Flow Statements

Joan Dickinson: Well, I don't understand. If you're studying to be a lawyer why that kind of of job? Toughening up the muscles for the football field?
Anthony Judson Lawrence: No.
Joan Dickinson: There must be some reason. 
Anthony Judson Lawrence: Hh-hhm.
Joan Dickinson: Well, give me a hint.
Anthony Judson Lawrence: Alright, it begins with a 'K.'
Joan Dickinson: Kick the can.
Anthony Judson Lawrence: No. Kold cash.
--The Young Philadelphians

Last time we reviewed income statements--the first of the financial statement trilogy. Today we'll take a look at cash flow statements.

It is often said that cash is the lifeblood of business. Because of vagaries in accounting procedure, it is quite possible for companies to report large profits on their income statements while being cash poor (why this is so is a topic for another day). The cash flow statement basically strips out expenses and accounting adjustments to provide a better sense of the cash economics of a business.

The essential metric to determine here is called 'free cash flow.' Free cash flow (FCF) represents the cash that is left over after a company pays for operating expenses and capital projects. It is calculated by taking operating cash flow (OCF) and subtracting capital expenditures (CapEx). Using the symbology:

FCF = OCF - CapEx

Let's stick with our Intel (INTC) example from last time. Referencing Intel's cash flow statement at the end of fiscal year 2018, observe that the company reported OCF of $29.4 billion and CapEx of $15.2 billion. INTC's free cash flow, then, amounts to $29.4 - $15.2 = $14.2 billion. That's good sized free cash flow.

I also like to look for trends in free cash flow. Ideally, FCF should be increasing over time. We can see that has been the case with Intel. The company's FCF has grown from about $12 billion in 2015 to about $14 billion in 2018.

Sizable and growing free cash flow. Those are signs of a business with strong cash economics--capable of supporting future business (and dividend) growth.

That's what we can learn from quick review of cash flow statements. Next time we'll examine the last of the financial statement trilogy: balance sheets.

position in INTC

Income Statements

"Things are bad around here but you're making big money. What's the bottom line?"
--Marv (Wall Street)

To be a successful investor, you must be comfortable with examining a company's financial statements. Publicly traded companies release three primary financial statements: income statement, cash flow statement, balance sheet. These statements express what a business has done, and offer some insight into what it can do in the future.

You don't need to be an accounting genius to make sense of financial statements. Here is a summary of the things I tend to look for in income statements (we'll cover cash flow statements and balance sheets in future missives). Let's use the income statement of Intel Corp (INTC) for reference. You can find all of Intel's financial statements on the Schwab site as well.

Although much attention is often paid to income statements, I tend to view them with less scrutiny. Investors often focus on 'net income' near the bottom of the income statement. This is the infamous 'bottom line' measure of profits. For its most recent fiscal year (ended 12/29/18), INTC reported net income of about $21 billion.

Here's the thing about net income. Because it is influenced by many accounting 'tricks,' net income is often more construct than reality. It frequently does not reflect the true cash profitability of a company.

Rather than focusing on the 'bottom line,' I usually pay more attention to the 'top line,' or total revenue. Revenue captures the dollar value of all goods and services sold by the company. Revenues are much harder to 'fudge' from an accounting standpoint; they provide a good measure of total stuff sold in the marketplace.

From Intel's income statement, we can see that the company realized total revenue of $70.8 billion in its most recent fiscal year. Note also that revenues have been rising steadily over the past four years. Sales growth is almost always a good thing.

Sometimes I also check out profit margins. There's gross profit margin and net profit margin. Using INTC:

gross profit margin = gross profit/total revenue = $43.7 billion/$70.8 billion = 61.7%

net profit margin = net income/total revenue = $21.0 billion/$70.8 billion = 29.7%

Anything over 50% gross and 10% net is good (and rare), which makes Intel's profit margins uncommonly good.

Next time we'll examine the cash flow statement.

position in INTC

Sovereign Debt Distortions

Watt: How's it feel to be carrying all that cash in your pocket?
Keith Nelson: Well, a little uncomfortable.
Watts: Want me to tell you one more time that I think you're crazy?
Keith Nelson: Nope.
Watts: Been hording that cash for years?
Keith Nelson: Yep.
Watts: How bad's your dad gonna ream you?
Keith: You won't be able to measure it with existing technology.
--Some Kind of Wonderful

On the back of yesterday's post about the inverting UST yield curve, some eyebrow-raising anomalies among sovereign debt yields worldwide help explain what we're seeing in Treasuries. Here are some rates on various 10 yr country bonds per WSJ as of this pm:

US   2.243%
UK  0.900
Sweden   0.005
Spain   0.765
Portugal  0.863
Netherlands   0.021
Japan   -0.081
Italy   2.651
Germany   -0.171
France   0.242
Belgium   0.320
Australia   1.543

Only two countries besides the US sport rates above 1% (!). Many are close to zero. In fact, yields on 10 yr German and Japanese bonds are negative, meaning that creditors are effectively paying debtors for the privilege of owning the paper.

What is going on? It's the global version of 'quantitative easing.' Central banks, namely the BOJ and ECB are buying sovereign debt in an effort to keep rates low. Interest rates on bonds go down when prices go up. As central bank buying programs bid up the prices of sovereign debt, yields shrink globally.

Although they may be difficult to measure with existing technology, the market distortions wrought by this activity help explain what is going on here in the US. If you are on the market for 10 yr sovereign bonds, which country offers the best risk:reward prospects?

As investors vote with their wallets, they are buying US tens in size, which is pushing their rates lower than would be the case in unhampered markets.

Market Cap

See the kids just getting out of school
They can't wait to hang out and be cool
--The Go-Go's

Recently we discussed valuation--the process of determining how much a security is worth. Once you estimate the security's 'fair value,' then you need to compare your estimate to the current market value to judge whether the security is fairly valued, overvalued, or undervalued.

How to obtain the current market value of a security? If that security is a stock, then current market value can be readily found by determining the stock's market capitalization, or 'market cap.' Market cap is calculated by multiplying the current share price by the number of shares outstanding (sometimes called 'float'):

market cap = price per share * number of shares outstanding

Let's use Target Corp (TGT) as an example. This morning, TGT shares are trading around $81.50. Currently, there are 512.3 billion TGT shares outstanding. TGT's market cap is:

$81.50/share * 512.3 billion shares = $41.8 billion

This is the value that the market currently places on the entire company. Suppose that you and I wanted to buy Target--not just a few shares but the entire company! To do so, we would theoretically have to write a check for $41.8 billion in order to take all shares off the market at the current price. (In reality, we'd probably have to pay more because shareholders, once they recognize that their company is a buy-out candidate, usually demand a premium over current market price before they are willing to part with their shares).

Market cap offers a decent idea of what the market currently thinks the company is worth.

A close cousin of market cap is enterprise value. Enterprise value tweaks market cap by factoring in a company's current cash and debt levels. Here's how it's found:

enterprise value = market cap - cash + long term debt

Let's return to the TGT example. Target's most recent quarterly balance sheet indicates cash equivalents of $1.2 billion and long term debt of $11.3 billion. TGT's enterprise value, then, is:

$41.8 billion - $1.2 billion + $11.3 billion = $51.9 billion

Technically, enterprise value provides a more accurate estimate of current market value because it takes into account a company's net cash position. When a company is carrying more debt than cash like Target currently does (a very common situation in today's world, btw), then the check that we would have to write to purchase the entire company conceptually increases because we would have to assume the debt obligations currently on Target's books.

Which one to use--market cap or enterprise value? While enterprise value provides a more technically correct estimate, the practical differences can be pretty small. In everyday market machinations, market cap is the more popular metric. It is widely reported--probably because it is easier to calculate. I pay attention to both and like to have a general idea of where market cap and enterprise values stand for the companies that I follow.

In market lingo, companies with market caps of $10 billion or more are often referred to as 'large caps.' Those with market caps between $1 billion and $10 billion are called 'mid caps.' Companies with market caps of less than $1 billion are deemed 'small caps.'

For reference, here's a list of the 50 largest US companies by market cap. Quick quiz: What company currently holds the title as the largest US company by market cap?

position in TGT

Net Worth

Don't you try to pretend
It's my feeling we'll win in the end
--Simple Minds

"Where do I stand financially?" One way to answer that question is to periodically estimate your net worth. Simply defined, net worth is the difference between what you own and what you owe. The more you own and the less you owe, the greater your net worth.

In financial accounting, the instrument for measuring net worth is called a balance sheet. When companies report their financial results, they include a balance sheet so that shareholders can understand the capital structure of the business and their underlying net worth (a.k.a. shareholder equity). Individuals can similarly employ the balance sheet approach to get an idea of their net worth.

Assets

First comes what you own, a.k.a. 'assets.' Record them, then add them up. Here's a list of typical assets, beginning with the most liquid:

Cash and cash equivalents. Value of checking accounts, savings accounts, CDs held in banks. Don't worry about physical cash on hand unless it's substantial.

Investments. Value of brokerage accounts, mutual funds, IRAs, 401(k)'s.

Alternative assets held in physical form. Precious metals, collectibles, other real estate besides personal dwelling. Value of alternative assets can be harder to estimate because they are less liquid. Be conservative with your estimates.

Home. If you own a house, include the property's estimated value. A conservative reference is often the county assessment done every few years for property tax purposes.

Car. Estimated selling price of a car if you have one. Remember that car values depreciate quickly, so be conservative.

Other personal property. For the most part, ignore possessions like clothes, electronics, etc. They usually have little 'salvage value' if you have to sell them.

Liabilities

Next comes what you owe, a.k.a. 'liabilities.' For the most part liabilities are various forms of debt. Record them, then add them up. Here's a list of typical liabilities.

Credit card debt if balance not paid off monthly.

Student loan debt--remaining balance that you owe.

Car loan debt--remaining balance.

Home mortgage debt--remaining balance.

Other debt. Rare but could include personal loans (money you've borrowed from another person) and other unusual obligations.

Don't include monthly bills like phone, cable, gas and electric as long as they are paid when due.

Net Worth

Once you've summed up your assets and liabilities, find the difference:

Net Worth = Assets - Liabilities

You want the number to be positive and growing over time. When you are just starting out, you net worth will be small. It may even be negative. The way to stay out of negative territory is to avoid debt. Stated differently, owning tons of assets matters little from a net worth standpoint if those assets have been funded by a mountain of debt.

The smaller your debt load, the quicker that you can build your financial net worth.

Personally, I estimate my net worth quarterly using a spreadsheet. Nothing to obsess over. Just a way to track progress along the way.